In a Special Edition of Employee Plan News, dated August 2007 and released by the IRS on August 28, 2007, the IRS may have resolved at least some of the controversy over cross-testing plan allocations by placing individuals in their own classification group. The Special Edition states that the Retirement Plans FAQ on Pre-Approved and Individually Designed Plan Programs has been updated to include this information:
Satisfying the “reasonable classification” standards with the required use of the cautionary language in the sample adoption agreement — The FAQ states that a nonstandardized M&P plan must use the cautionary bolded language (beginning, “The specific categories of participants…”) if the plan chooses the participant group allocation method. Because doing so creates a separate allocation rate for each eligible employee, the regulation prohibiting the classification of employees by name will be disregarded.
The actual FAQ states:
7. A number of practitioners have inquired – how does the Sample Adoption Agreement Language of Section A, Participant Group Allocation work in operation?
Background: Revenue Procedure 2005-16, 2005-1 C.B. 674, allows adopting employers of non-standardized defined contribution Master & Prototype (M&P) plans to adopt an allocation formula that is designed to be cross-tested for nondiscrimination on the basis of equivalent benefits under I. T. Regs. 1.401(a)(4)-8.
The Service issued cross-tested language in LRM #94 in October 2006. The language in LRM #94 is designed to allow the adopting employer of an M&P plan to select either a participant group allocation method or an age weighted method for determining allocations under the plan. LRM #94 restricts the number of allowable allocation rates under a non-standardized M&P plan using the participant group allocation method, based on the number of NHCE’s and HCE’s in the plan. While the purpose of LRM’s is to assist sponsors of M&P plans in drafting plan language to conform to applicable law and regulations, it is generally not mandated. However, in order to effect consistent application of cross-testing for nondiscrimination purposes in M&P plans the Service has taken the position that non-standardized M&P plans must follow the language contained in LRM #94 in order to receive an opinion letter.
Answer: By selecting the participant group allocation method, the employer agrees to divide plan participants into a limited number of allocation rates, (groups). Each group will have the same allocation ratio. The number of groups will be limited as provided in the sample plan language. The determination of the allocation rates under the plan and the division of participants into groups must occur on or before the due date of the employer’s tax return, including extensions, for the year of allocation.
For this reason, the blank/fill-in of the Sample Adoption Agreement Language may be filled in with the following phrase or something similar thereto: “on or before the due date of the employer’s tax return for the year of allocation through written instructions from the employer to the plan administrator or trustee.”
8. Is the cautionary language in bold under Participant Group Allocation of the sample adoption agreement required language, and how are the reasonable classification standards under Regs.1.410(b)-4(b) of this language satisfied in operation?
The cautionary language is required language for a Nonstandardized M&P plan. However, since the Participant Group allocation method provides that each eligible employee will constitute a separate allocation group, the last sentence of Regs. 1.410(b)-4(b) will be disregarded for purposes of meeting such classification standards.
The last sentence of Treasury Reg. 1.410(b)-4(b) which is being disregarded states:
An enumeration of employees by name or other specific criteria having substantially the same effect as an enumeration by name is not considered a reasonable classification.
By disregarding this last sentence, the IRS seems to have resolved the issue on whether a plan using a cross-tested allocation formula can place individuals in their own classification group. This is a change for the IRS from a position taken earlier this year, when the IRS was challenging individual classification in cross-tested plans as not meeting the reasonable classification standard.
[tags]IRS, individual classification, cross-testing, cross-tested, allocation, 401(a)(4), LRM #94, reasonable classification, pension, retirement, ERISA[/tags]